How can Supply-Side Policies be used to achieve Economic Growth? To see more of our products visit our website at Andrew Threadgould

Economic growth occurs when the productive potential of the economy increases over time. This can be shown by the production possibility frontier (PPF) shifting outwards. Demand management and supply-side policies are the 2 main methods used to influence output levels in the macro-economy. Demand management policies influence the actual level of spending and can be divided into fiscal and monetary policy. Demand management policies affect the position of the aggregate demand curve and are an important influence on output, jobs and prices. Supply-side policies are directed at potential rather than actual output.

Capital spending is used to improve existing, or create new, hospitals and schools etc. Current spending funds day-to-day costs such as public sector wages. Supply-side policies tend to involve either a change in legislation or significant levels of government capital spending. Supply-side policies include improvements in education, healthcare and transport infrastructure plus programmes to include the mobility of factors of production.

Supply-side policies are associated with increasing productivity – raising output per factor input. They are also associated with efficiency – reducing average costs of production or forcing firms to keep prices as close to marginal cost as possible. This is because it takes a long time for improvements in both the private and public sector to produce for example, happier, healthier and better educated workers. Supply-side policies are regarded as being more effective in the long- run than the short-run.

Supply-side policies have shifted out the long run aggregate supply curve to LRSA2. The short-run aggregate supply curve has moved down to SRAS2 as a result of higher productivity and/or lower costs per unit. The overall result is one of higher output at Y2 and significantly lower prices at P2. Supply-side growth such as this is known as non-inflationary growth since unlike when aggregate demand shifts outwards, prices may fall rather than rise. This in turn may improve the country’s current account.

Improvements to healthcare should reduce absenteeism from illness, increase output as physical and mental health improve and possibly increase the labour force if retirement ages rise in line with life expectancy. Improvements in education and training lead to a higher-skilled and better qualified workforce, and possibly result in more people working in higher value sectors. Improvements in transport infrastructure help to reduce transport costs and travel times, with goods reaching the market more cheaply and labour mobility being increased. Increasing incentives via lower marginal rates of income tax and corporation tax encourages workers and entrepreneurs to find or create jobs and increase output.

Privatisation transfers ownership from the public to the private sector, where the profit motive may result in a more rigorous control of costs of production Subsidies for invention, innovation and investment can lead to a dynamic and innovative business sector with the creation of better technologies to drive down costs and increase productivity. Stronger competition policy and the deregulation of markets will cause firms to operate more efficiently or face greater competition and/or contestability. Reducing trade union power may reduce wage pressures for affected industries and thus reduce labour costs.

Growth in potential output will only be of benefit if actual output rises. If there is a lack of demand in the economy this may not happen. Another problem is that of opportunity cost. Policies requiring significant investment, like transport infrastructure, may be overlooked in favour of policies which give a quicker improvement in living standards. Capital spending projects can be controversial. Reducing the marginal rate of tax to increase incentives to work will probably lead to a fall in tax revenue and a worsening of the budget position. It may also create greater inequality. Changing employment legislation and trade union power may reduce job security and lead to greater stress and lower productivity in the workplace.

Greater mobility of labour may affect occupational pension schemes and leave workers more dependent on state pensions when they retire. There is also the problem of unexpected outcomes when something like additional investment in the NHS leads to an increase in bureaucracy instead of increasing the population’s health. Supply-side growth may arise independently of supply-side polices such as when the private sector invests and innovates for its own reasons.

A free market economist would argue for small government, low taxes and a liberated business environment to raise productivity and create long-run growth. A left-wing economist would argue that protecting workers from exploitation by businesses and by the state providing key goods and services would achieve the same objectives of raising productivity and growth. But supply-side policies are essential to the long-run performance and health of the economy, offering non-inflationary growth in output and jobs when working at their best. However, there is potential for government failure and so supply-side policies remain controversial amongst economists.

Supply-side policies are one method of influencing the state of the macroeconomy alongside demand-management policies. Supply-side policies aim to influence potential output and involve changes in legislation together with changes in government spending such that productivity is enhanced. These policies seek to deliver non-inflationary growth. However, they have opportunity costs, involve time lags which may be quite long and can also have unexpected outcomes thus resulting in government failure.

What factors might explain why the UK economy invests less, on average, than similar economies? Long time lags and political pressures are examples of government failure. What other forms of government failure might be experienced at a macreconomic, rather than microeconomic, level? What do economists mean by the ‘mobility of labour’? Identify one advantage and one disadvantage to workers of ‘greater labour mobility’. Is inequality good or bad for the economy? To what extent does it increase rather than limit incentives to work? “The huge budget deficit in the UK in 2010 makes effective supply-side policy more important than ever.” To what extent do you agree with this statement.